LOOKING FOR ANSWERS

The successful run that software partners were enjoying for a long time now,
seems to be coming to an end. While they had learned to come to terms with
issues like software piracy, high software prices and customers unwilling to pay
a price for high-priced software, now they have a new issue at their doorsteps.
And this one has been thrust on them by the government itself in the form of
ambiguous taxation on software.

What is compounding their problems is that there is no clarification from the
govern­ment, distributors or vendors about the exact level, amount or nature of
tax that is applicable on software sales. In face of this lack of clarity most
partners are simply interpreting the taxation laws in their own ways and hoping
that they are doing the right thing.

This is why DQ Channels undertook the task of under­standing the taxation
policies involved on software business and the changes announced recently, in
order to shed light on some of the issues and problems faced by the partners in
this trade.

Packaged software

The packaged software is also sometimes known as standard software, canned
software or normal software. This type of information technology software is
developed by software companies to meet the require­ments of a large number of
users.

(L-R) Hemant Chabria of Chabria Infotech, Devesh Aggarwal of Compusoft, Prabhakar Kini of Kinfotech, Kaustubh Kulkarni of Fusion Software, Harinder Salwan of Tricom International, Vipul Dutta of Futuresoft, Sudarsan Ranganathan of Veeras Infotech, Rajesh Kothari of Blue Chip Computers, Ashish Shah of Vista Info Systems and Dnyanesh Kulkarni of Dataformatics at ISODA's recently held national meet

Packaged software by nature is a branded one and is usually shrink wrapped
and sourced from vendors like Adobe, Autodesk, Computer Associates, Microsoft,
Novell, Oracle, Red Hat, Sybase, Symantec, K7 Computing, etc. These compa­nies
then appoint national distributors like Ingram Micro India, Redington, Neoteric
Infomatique, eSys, etc or regional distributors, in India.

The other type of software is customized software or tailor-made software.
Here, a certain software is taken as a base and then tweaked to meet the
requirements of a particular customer. This software then needs to be tested and
deployed at the client site by solution providers who are equipped to do it.
(See box on page 6 for different types of software).

No law states that a product attracts double tax, and it is happening only for the people in packaged software industry Alok Gupta CEO, Softmart Solutions, Delhi

While purchasing the packaged software, the end customer is provided with a
license to use it, subjected to the terms of the license. Usually such licenses
are perpetual in nature, unless terminated by either the seller or the end-user.
It is a well-settled legal view that this transaction is a sale of packaged
software and not a service rendered to the customer by the reseller.

Items like full packs, OEM packs, paper licenses and Internet downloads are
called packaged software, which are purchased and sold, and VAT (Value Added
Tax), which was earlier sales tax, is charged for all these products. Software
maintenance and subscription, which are termed as services, attract service
charge. And finally data/information subscription attracts service charge when
sold by a service provider and attracts VAT when the subscriptions are sold in a
package form.

Business scenario

Packaged software dealers normally purchase software licenses and software
mainte­nance from the distribution companies located in India, whose
suppliers-usually located outside India-ship the software product boxes and
licenses. They get them cleared from the customs after payment of requisite
customs duty and deliver it to the software reseller along with the invoice.
Dealers also purchase software from overseas software companies or their
distributors through their website and make payments using credit cards or wire
transfers.

Dealers have been paying sales tax, which is now VAT, for more than 20 years
for the packaged software they were selling. With respect to the service tax
circular No 81/2/2005 dated 7/10/2005, they started paying service tax for items
like software maintenance and subscription.

The whole business scenario was calm, composed and hassle- free for dealers
in the packaged software industry, till four to five years ago, despite
cut-throat competition and wafer-thin margins. It was only after the government
and tax department decided to change the taxation structure for software that
partners started getting worried.

Alok Gupta, CEO, Softmart Solutions Delhi recalled, “We were doing fair trade
amidst cut throat competition. Since the business was booming at that point of
time, the market was good and we were able to sustain in the business despite
the low margins. I feel that the govern­ment might have misunderstood that
software dealers were making lots of money during India's boom time. The whole
business has today assumed a dreary outlook after the government started levying
various taxes one by one followed by service tax during 2005 for services like
software maintenance and subscription,” Gupta said.

Double taxation

On May 16, 2008 a new category of taxes for services provided in relation to
information techno­logy software for the use in the course, or furtherance, of
business or commerce (Section 65 (105) (ZZZZe) ) was included in the list of
taxable services. As a result, software dealers were asked to charge service tax
on the basic price and then charge VAT on the basic price plus service tax.

The move came as a bolt of thunder to channel partners. “Already partners
operate on a very narrow margin of about two to three percent. After the
government's decision to charge additional service tax on the sale of software
licenses, the whole business has come under trouble, as the amount is really
huge when we need to add four percent VAT and 12.36 percent service tax, which
customers aren't agreeing to. Needless to say, we are caught in the middle,”
said Sudarsan Ranganathan, CEO, Veeras Infotech.

According to Ranganathan, the levying of service tax on packaged software is
against the well established legal position that packaged software falls under
the goods (product) category and is liable to sales tax (VAT) alone. “Levying of
service tax and sales tax on packaged software license is clearly a case of
double taxation, which is found no where in the laws of the government.
Therefore, suitable steps need to be taken to clarify this situation,” he said.

Normally, when a product attracts service tax, it attracts other taxes like
income taxes too. So by selling software with double taxes for 16.36 percent,
partners will also end up losing nearly 11.33 percent in the TDS deducted by
customers. Partners believe that this is wrong as again the TDS is said to be
applicable only while performing services, which box pushers don't do.

Discontent partners

According to Manoj Kumar Agarwal of Ashram Computer Consultancy Services,
Benguluru, paying service tax for selling box products is really an absurd
thing. He added that charging double tax is unacceptable as many customers will
not agree to pay both the taxes.

“Without giving any clarifi­cation, distributors are asking us to pay the
service tax besides the VAT. How can a product attract two taxes? The
distributors claim that they are being forced to do this by the Service Tax
Department, which is really unacceptable as one should not do anything abnormal
just because somebody is forcing them to do so.”

What is rankling partners even more is the 11.33 percent TDS being deducted
by customers due to the presence of service tax in the product. The claims by
dealers seem to be very practical. For instance, they have to operate on more
than 11 percent margins for every software order taken upfront if they need to
pay for the procurement. If one does Rs 25 crore of business every year, he
needs to fund Rs 2.83 crore from his pocket for the TDS, and should make a
profit of Rs 8.5 crore to set off the TDS against tax liability which amounts to
34 percent PBT.

Dealers fear that the double taxation might leave them in a position where
their entire working capital might get affected in the long run. “If we are
billing a license with service tax and VAT then the end user reduces 11.33
percent on the entire payment he is going to make and the dealer loses about
eight to 10 percent of his money to the income tax department. And after
hundreds of transactions, he will be left with no working capital,” said V Anand,
CEO of Chennai-based Raksha Technologies.

Supporting Anand's thoughts, Gupta of Softmart Solutions shared that TDS is
the biggest problem for the software channels today. “The basic thing that
everyone should under­stand is that partners aren't agitating for the 12.36
service tax that is implied, as the partners are going to get it from their
customers. However, the main issue here is the TDS, which chocks the entire cash
flow of a partner, including the working capital,” said Gupta.

Harinder Salwan, CEO, Tricom International informed, “Since paper licenses
account for 80 percent of the business, the presence of service tax and VAT is
of great difficulty to the partner. When a product attracts service tax, TDS
also comes into play. It might take more than two to three years to get the
returns from the income tax department, due to which there is no other option
but to suffer loss.”

Prices vs piracy

As a result of the double tax, there has been a notable increase in the
prices of software, where an end user has to pay almost 16.36 percent extra per
license and when the volumes go up, the investment in software also increases
for any company. Due to this, partners fear that software piracy is also likely
to increase to a great extent.

Again the double tax accounts for CVD (counter veiling duty) paid for an
imported license. Despite paying 12 percent CVD for the imported licenses,
partners have been asked to pay service tax of 12.36 percent and finally four
percent of VAT. As a result a dealer has to pay nearly 28 percent tax for any
imported license and 11 percent TDS would be deducted from him.

“Customers lose interest in paying for the original software, when they feel
that they need to pay 28 percent extra per license and as a result piracy levels
and software counterfeiting would see a rise,” said Ranganathan.

Gupta of Softmart Solutions claimed that CVD and service tax are mutually
exclusive and can't be charged at the same time. “Whatever is happening on the
tax front for software dealers is happening without any clarifi­cations from the
government and is against law. No law states that a product attracts double tax
and it is happening only for the people in packaged software industry,”
exclaimed Gupta.

“If CVD is paid for a product, basically that doesn't attract a service tax.
There is total confusion from the roots and if only we seek answer from the root
cause can there be some amount of clarification,” said S Karthikeyan, CEO, Bloom
Electronics, Coimbatore.

According to T Gunasekaran, Advocate-Excise, Customs and Service Tax, and
Advisor, TVC Institute of Management, Mumbai, the term double taxation implies
same tax levied twice on the same amount. He says that the constitution of India
permits the levy of taxes by central government and state government on the
subjects allotted to each one. “As regards the software, the packaged software
are treated as goods manufactured, which is subject to excise duty under Tariff
Item 85.24 and liable to sales tax when sold as held by Supreme Court in the
case of Tata Consultancy Services Ltd (2004-178-ELT-22-SC). The packaged
software are those that are available off the shelf and do not require
customization. Only customized software have been brought under the purview of
service tax with effect from May 16, 2008, and it is treated as services
provided by the IT company to the customer and hence it is subject to service
tax now,” he clarified

According to Gunasekaran, VAT is a tax on the goods sold which is levied by
the state government and hence irrespective of the excise duty or service tax
paid on the software, if it fulfills the condition of sale of goods as defined
under the state VAT/central sales tax, it would also attract VAT/sales tax. “It
may be noted that VAT/sales tax is payable on excise duty

also. It was held by the Supreme Court that since software can be of
abstraction, consumption, use, transmission, transfer, delivery, storage,
possession, etc, it was included as 'material, articles and commodities' in the
definition of goods under Section 2(h) of Andhra Pradesh General Sales Tax Act
1957 and accordingly IT sales by the licensee was liable to sales tax. It was
further ruled that plea software was not tangible movable property and hence not
goods was rejected,” he claimed.

Gray areas

Apart from double taxation, there are too many challenges being faced by
software resellers. The government is charging different rates of excise/customs
on packaged software licenses depending upon whether it is a box product or a
paper license or an Internet download. Due to this bifurcation of software
license under three categories there is a lot of confusion among the importers
as to what rate customs duty is payable. Under excise and customs there are more
than one classification for packaged software product.

For example, packaged software comes under customs heading: 85244011 and it
is liable to attract 12 percent CVD. While paper licenses come under custom's
heading: 49070030 and is liable to attract 12.5 percent customs duty but it is
Exempt Vide Sr No157 of Notification No 21/2002-Cus dated 1/3/2002. Adding to
the confusion, there is no classification of packaged software downloaded from
Internet. Under excise/customs through explanatory notes 85.2 Central Excise
2006 states that software downloaded from Internet and customized software will
not attract duty.

Since the software falls under three classifications depending on their
delivery, there is a lot of confusion among the distri­butors, as well as the
customs officials in determining the classification under which customs duty is
payable on a particular import.

To further complicate the situation the distributors charge VAT on box
products, media packs, OEM packages, paper licenses accompanied with media and
charge service tax plus VAT on paper licenses and Internet download.

Recently, one more issue has cropped up, where the dealers have been asked to
pay 12.36 percent service tax for the back-end payments or incentives that they
received from vendors. And the have been asked to pay back-end rebates that they
received from vendors since 2004 and pay service tax accordingly. “There is so
much of ambiguity in the rules and regulations levied on us. Software work on
back-end rebates, and if service tax is applied on them then we wouldn't be able
to survive in the business,” lamented Rajiv Warrior, CEO, Alladin Softwares.

R Mahesh, CEO, Ozone Computers, Coimbatore is of the thought that the
back-end claims from the vendors are purchase based rebates, so they don't come
under business ancillary services and hence shouldn't attract service tax. “The
central exercise department has levied the service tax considering that the
dealers are involved in brand promotional activities (selling vendors products),
which is not agreeable. Our activities don't come under business auxiliary
services and the purchase based rebates can't attract service tax at any point
of times,” said Mahesh.

On the other hand Anand of Raksha Technologies, Chennai felt that the income
tax department gives preferential status to few people who pay more tax by
subsidizing their taxes. “I have experienced this preferential treatment where,
few people who are dealing in volumes can just pay the subsidized percent of tax
rates, while the others need to pay 11.33 percent TDS. There is no clarification
from anybody on this issue including our tax officials and the day-to-day
business is like walking on knife for our partners,” he claimed.

The confusion

There is so much of ambiguity that nobody is clear on what accounts the
taxes are levied. “There are almost 20 inter-pretations for double taxation and
we aren't sure about following a particular thing. We have been lobbying with
each and every department staring from the service tax department, and have
raised the issue at the finance ministry level. However, we are yet to get any
sort of information from anyone,” said Ranganathan.

Gupta of Softmart felt that the main reason for the formation of Infotech
Software Dealers Association (ISODA) is to form a group and fight the issues
that software dealers face every day. “It is really difficult for a single
person to approach the various tax departments. So we formed ISODA only for that
reason; to fight the issue as a group, as only then will somebody would at least
listen to us,” Gupta said.

Since the formation of ISODA last year, the association has been carrying out
various activities like conducting regional meetings in Mumbai, Delhi, Bengaluru
and Chennai, besides holding its first national meeting in Mumbai recently. The
meetings have been discussion forums with various seminars on the different
taxes in the trade. ISODA has also taken up the issues with different government
departments and different levels of people, but has yet to hear from anyone.

“The ISODA partner community is together and consults with each other using
the ISODA platform. ISODA has become the only and best platform available for
partner community to understand the nuances of the business and now understand
the do's and don'ts while conducting business,” said Rajesh Kothari, President,
ISODA.

It is also not quite clear on how many partners have actually taken legal
support from lawyers and service tax experts and taken legal course of actions.
On the big gap that exists between the legal team and the partners, Ranganathan
was quick to respond, saying that entering into legal actions takes a whole lot
of time and the dealers need to be prepared to fight the case till the Supreme
Court. He also claimed that the legal experts charge lakhs of Rupees per sitting
and still there are only interpretations but no clear cut advices or
suggestions.

Also, one should accept the fact that there are not many charted accountants
or any other tax consultants, who have expertise in the service, excise and
customs duty. Only few lawyers, who have good expertise in the taxations are
available in the country and that again creates a major gap between the dealers
and the legal team.

Kothari added that if required the issue would be solved using the legal
route. “Tax issues faced by ISODA members are complex and are difficult to
manage at a member level. Hence ISODA has taken up these issues at appropriate
level. We are working on the resolution of the same and if need be we will
resort to a legal route. We have devised a strategy for the same. All management
committee members have given consent for the planned action(s) and have clarity
on the possible resolutions to be achieved from such proceedings,” he claimed.

Gunasekaran, the legal expert, said that a person engaged in manufacturing
packaged software is required to get registered under central excise and pay
excise duty at eight percent as applicable today on their removal based on the
transaction value, ie the price at which sold. “If a person is engaged in
developing the customized software, he is required to get registered under
service tax and pay service tax at12.36 percent on the gross amount charged to
the customer under the Information Techno­logy Service,” he informed.

The definition of Information Technology Service as per Section 65(53a) of
the Finance Act, 1994, reads as, “Information Technology Soft­ware means any
representation of instructions, data, sound or image, including source code and
object code, recorded in a machine readable form, and capable of being
manipulated or providing interactivity to a user, by means of a computer or an
automatic data processing machine or any other device or equipment for VAT,
registration has to be sought under the respective State VAT Act and the tax is
payable as per the provisions of the corresponding VAT Act.”

Hence, it is clear that the dealers reselling the box software products and
licenses just need to pay the VAT or CVD for the importing licenses not the
service tax as they aren't involving in any customization.

Even Gunasekaran claimed that those back-end payments can't attract service
taxes as they are purchase based rebates.

Vendor, disti support

Salwan of Tricom International, claimed that no vendor has ever tried to clarify
why there have been so many issues with respect to the tax for a software
partner. “There are so many inter-pretations of rules. Vendors haven't even
bothered to help the partners in getting things clarified and they have proved
that they are an outsider and have nothing to do with the taxations in this
country,” said a furious Salwan.

Not many dealers want to talk about the support being provided from the
vendors as well as distributors in this issue as nothing has been done from
their end and people are tired talking about it.

When DQ Channels tried to contact vendors and distributors, none bothered to
reply, except Microsoft.

“Till recently, packaged software was treated only as a good, and taxed
accordingly (subject to excise duty and VAT). The introduction of taxable
service category called IT Software Services with effect from May 16, 2008 has
created some ambiguities on tax structure applicable for packa­ged software
which can amount to double taxation. We and the IT industry at large continue to
provide our inputs and engage with the government directly, and through industry
forums such as Nasscom, to seek further clarity,” said a Microsoft spokesperson.

He also said that the Microsoft sells in India through a partner network and
their partners are independent businesses who are responsible for their taxation
and legal issues associated with running any business.

The lack of interest shown by vendors and distributors clearly shows a couple
of things with regards to these issues. One is the clarity that is missing among
them with respect to the taxes. Secondly, it raises a question about their
commitment to the channel community.

As rightly said by Gunasekaran, ISODA on its part is also trying out various
means to resolve the issues faced by its community through education programs
and protests.

NR Sethuraman

sethuramannr@cybermedia.co.in